Going, going, Gold!!

Although overshadowed by yet another period of pointless speculation over the warming or cooling of Sino-US trade tensions, we actually witnessed a significant market event this week – gold hit a six-year high.

So what?

Well, it’s true that, of themselves, such sound bites of market trivia are more interesting than relevant. I well remember the spring of 2000 when a publication as revered as the Financial Times ran a headline which stated that the Dow Jones Industrial Average had shed its second-largest amount of points in one day in its history. I felt obliged to write to the editor (yes, we still wrote letters in 2000) and point out that it was, in fact, the 11th largest one-day fall in percentage terms, while asking why his newspaper was stooping to running ‘tabloid’ headlines.

Now the point about gold hitting a six-year high is not that it’s hit a six year high! Technical analysts will be falling over themselves to point out that the yellow metal has broken out of a long-established trading range and we can now look forward to further breakouts and some fascinating ‘triple top’ or ‘head and shoulders' patterns forming – interesting, that is, if it's ‘your bag’ to lock yourself in a darkened room, surrounded by computer screens, trying to discern valuable information from a wobbly line!

Not that I’m dissing technical analysis in any way. All reputable investment professionals will tell you that momentum is a hugely important factor and many ‘trend followers’ have enjoyed a fabulous lifestyle on the back of this one truism alone. But context is also important. Why should momentum gather in the pricing of bullion?

Let’s start with historic pricing. A large number of private investors have looked to secure a bargain (and failed) by buying assets that are priced at levels well below peak. I myself bought shares in Eurotunnel at 1/10th of the flotation price in the mid 1990s. 25 years later, and before transaction costs, I have made a paper profit of around ￡194 (well done, Gibbo!). The point is that some companies become more profitable and some ‘die’ (literally or metaphorically). But, gold is gold. As warren Buffett famously quipped, "Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it.”

Bullion has no fundamental or intrinsic value and is not subject to the vagaries of the quarterly reporting season in either absolute or relative terms. However, it is a precious metal and, as such, is viewed as a store of value. Consequently, if an investor was willing to pay $1917 for a troy ounce of gold in 2010, the chances are that they will be willing to pay that amount or more in the future.

Here’s the context…

This week’s six-year high took the price of bullion to a level just below $1439. By my calculations there is more than 33% upside before we hit a new all-time high. And there are some solid reasons for believing this should happen in the period ahead.

First and foremost, the economic outlook has taken a marked turn for the worst and even the Federal Reserve is admitting defeat. I have been criticised for stating that the Fed only embarked on its hiking cycle to give it some wriggle room when everything turned ugly. Now that the yield curve is pricing in three rate cuts before the end of the year, Powell and co’s only regret is that they didn’t jam in more hikes earlier.

Of course, the relevance of this is gold, like government bonds, is considered a safe haven. As Ambrose Evans-Pritchard pointed out so eloquently in The Telegraph this week, with over $12 trillion of Eurozone government debt trading at negative yields, safety first Europeans have two options: They can “pay Portugal’s Socialist Government to look after [their] money until the mid-2020s or buy a bar of gold that is nobody else’s liability.”

The second salient point is that central banks are no longer net sellers of gold, as they were at the beginning of the GFC. US Treasuries have ceased to be their choice of safe haven asset. This is probably mainly down to Trump’s ‘America First’ policies but it could be an early acknowledgement that fiat currencies are effectively dead – debauched and devalued by electronic money creation. If the dollar is effectively on life support, so are US Treasuries!

In fact, central banks around the world proved substantial net purchasers of gold during the calendar year of 2018, increasing their reserves by around 650 tonnes (a 74% increase on 2017), making them responsible for around 15% of global demand. This is the second-highest amount ever purchased in a single calendar year, only eclipsed in 1967 when the US dollar was still pegged to bullion. It is now estimated that central banks collectively hold nearly 34,000 tonnes of gold reserves.

The ‘Big D’

For the third and final point, I would like to switch the discussion back to the ‘good ole greenback’. There is a particularly special relationship between gold and the US dollar, making the policy stance of the Fed especially pertinent, since gold (and other commodities) are priced in US dollars. When the value of the US dollar increases relative to other global currencies, gold becomes more expensive (in non-USD terms) and this naturally limits demand. Similarly, it is important to bear in mind that gold is a zero-yielding ‘currency’, which means there is an opportunity cost associated with holding bullion in a rising rate environment. In 2018, the Fed raised interest rates four times and tightened monetary policy further by reducing the size of its balance sheet. These decisions were viewed by most (but not the cynical Gibbo) as an attempt to front-run the prospect of rising inflation, meaning that real interest rates would inevitably rise in the short term.

All that has changed completely and the ‘Big D’ (deflation) is well and truly back on the table.

When everything around me is depreciating in value, would I buy a shiny bar of gold?

You bet I would!!

The views conveyed in the above post are solely my own. If you have enjoyed reading this, please feel free to like or comment. I am currently seeking a new professional challenge and would be delighted to consider freelance work or temporary/permanent contracts as and when suitable positions become available. Please contact me via LinkedIn or send an invitation to connect.